Shanghai Huayi Group (SHSE:600623) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Shanghai Huayi Group Corporation Limited (SHSE:600623) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Shanghai Huayi Group

What Is Shanghai Huayi Group's Net Debt?

The chart below, which you can click on for greater detail, shows that Shanghai Huayi Group had CN¥12.4b in debt in June 2024; about the same as the year before. However, its balance sheet shows it holds CN¥18.0b in cash, so it actually has CN¥5.64b net cash.

A Look At Shanghai Huayi Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Shanghai Huayi Group had liabilities of CN¥26.8b due within 12 months and liabilities of CN¥8.59b due beyond that. Offsetting this, it had CN¥18.0b in cash and CN¥3.58b in receivables that were due within 12 months. So its liabilities total CN¥13.8b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥15.5b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Shanghai Huayi Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Shanghai Huayi Group made a loss at the EBIT level, last year, it was also good to see that it generated CN¥872m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shanghai Huayi Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Shanghai Huayi Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, Shanghai Huayi Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although Shanghai Huayi Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥5.64b. And it impressed us with free cash flow of CN¥4.0b, being 457% of its EBIT. So we are not troubled with Shanghai Huayi Group's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Shanghai Huayi Group has 2 warning signs we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.